Yawn alert: This column is yet another boring review of the stock market’s dismal prospects between now and 2030.
Ignore the message of this column at your peril, however. The stock market’s long-term potential is one of the most consequential determinants of your retirement financial plan’s success—if not the most consequential. If, as some believe, the stock market is on the verge of another decade like the 1920s—a roaring ‘20s scenario—then you would of course want to increase your equity allocation.
But you would want to do just the opposite if the stock market is entering into a dismal decade. Reducing your equity exposure would be in order not just if another Depression or Financial Crisis were imminent, but even if the next decade is simply an overall flat market accompanied by a stagflating economy, such as in the 1970s.
Not to bury my lead too much: The stock market’s prospects over the next decade are dismal. It would go against an overwhelming body of historical evidence for the stock market over the next decade were to perform at anywhere close to its long-term average.
That doesn’t mean it won’t do well this year, or over any other shorter-term period. Take 2020. You may recall that, one year ago, I reported a similar conclusion about the stock market’s longer-term prospects. And the S&P 500 SPX,
But the stock market cannot forever remain disconnected from underlying fundamentals.
Unfortunately, those fundamentals suggest that the stock market’s return between now and 2030 is even lower than it was a year ago. Take a look at the accompanying chart, which focuses on a host of valuation indicators that historically have done the best job forecasting the stock market’s subsequent 10-year return. In addition to showing what those indicators are now projecting, the chart also shows what they were projecting a year ago.
In each case the stock market’s prospects today are worse than they were then. On average a year ago, for example, these indicators were forecasting a minus 0.7% annualized 10-year return on an inflation- and dividend-adjusted basis. Today, in contrast, that average is minus 4.1% annualized.
You shouldn’t be surprised by this, by the way. These reduced prospects are simply the other side of the coin of stocks’ spectacular 2020 returns. If you want above-average returns this year, then you must also accept below-average returns thereafter—unless you subscribe to the magical thinking that the market can produce above-average returns indefinitely.
Of course, many analysts for several years now have been issuing warnings about the overvalued stock market, and as a result many investors have stopped listening. How long should you give these pessimists the benefit of the doubt?
For insight, I turn to Jeremy Grantham, the co-founder of the Boston-based investment firm GMO. Earlier this week, Grantham insisted that the current stock market is “one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”
Grantham has been bearish on U.S. equities for so many years now that you might dismiss his latest comments as nothing more than the grumblings of a perma-bear. But you should recall that he turned bullish at the end of the Financial Crisis, catching the exact low of that bear market almost to the day. His bullishness then was as lonely a position as his being bearish is today.
Grantham this week wrote that investors should have great patience while waiting for the current bubble to break: “These great bubbles are where fortunes are made and lost — and where investors truly prove their mettle…Make no mistake — for the majority of investors today, this could very well be the most important event of your investing lives.”
As for the timing of when the bubble might break, Grantham speculates: “My best guess as to the longest this bubble might survive is the late spring or early summer, coinciding with the broad rollout of the COVID vaccine. At that moment, the most pressing issue facing the world economy will have been solved. Market participants will breathe a sigh of relief, look around, and immediately realize that the economy is still in poor shape, stimulus will shortly be cut back with the end of the COVID crisis, and valuations are absurd. ‘Buy the rumor, sell the news.’ But remember that timing the bursting of bubbles has a long history of disappointment.”
A ‘kids market’
Another way of thinking about stocks’ prospects in coming years is to recall the classic description of the market’s cycle provided by Adam Smith, the pseudonymous author of the classic book in the late 1960s entitled The Money Game. He used the phrase “kids’ market” to refer to market environments like the one we’re in now—speculative periods in which the advisers and traders making the most money are those too young to remember prior bear markets.
Smith described a friend of his on Wall Street called The Great Winfield, who exploited kids’ markets by only hiring investment managers who were not yet 30 years old: “The strength of my kids is that they are too young to remember anything bad, and they are making so much money that they feel invincible. Now you know and I know that one day the orchestra will stop playing and the wind will rattle through the broken window panes, and the anticipation of this freezes [the rest of] us” who are old enough to remember.
Smith referred to the stocks that the below-30 generation was buying as “swinger stocks.” At the time he wrote his book, the swingers had names like “data processing” or “computer” in their names. Today the swingers are securities such as Tesla (up more than 700% over the last year) and bitcoin (up more than 460% over the last year, and which has doubled over just the last three weeks alone). But the underlying pattern is the same.
In Smith’s telling, Winfield sneered at an older manager who had trouble getting on board with the “swinger” stocks. “Look at the skepticism on the face of this dirty old man…Look at him, framing questions about depreciation” and the like. “You can’t make any money with questions like that.”
Winfield’s point: “Memory can get in the way of such a jolly market, that malaise that comes with the instantly gone, flickering feeling of déjà vu: We have all been here before.”
If you’re reading this column, you’re most likely a graybeard yourself. You remember long, drawn-out and devastating bear markets, the slings and arrows of outrageous fortune—and this memory keeps you from getting on board today’s swinger stocks. My advice: Don’t try to become one of today’s “kids.” Even though, as Grantham puts it, “there is nothing more supremely irritating than watching your neighbors get rich,” we know how this story will end—and it won’t be pretty.
As Smith writes at the end of his chapter about the Great Winfield: “There is no stopping the flow of the seasons.”
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